Forming The Subchapter S Corporation. Advantages and tax overview

To do List: The steps for forming the S-Corporation are almost the same as the regular Corporation(also known as C-Corp). Follow the steps in the corporation section . After completing the incorporating steps: The shareholders are required to file IRS Form 2553 (http://www.irs.gov/pub/irs-pdf/f2553.pdf) This form will will transform the corporation into a subchapter S-corporation

Setting up as an S-Corporation allows you to have the limited liability of the regular corporation and the pass-through taxation of a sole proprietorship or a partnership. In other words, you pay taxes from corporate income on your personal income taxes.

Nowadays, for a small entrepreneur, it is more convenient to set up a Limited Liability Company (LLC) as it holds the limited liability benefits of the corporation and the flexibility of a sole proprietorship or a partnership.

Advantages of an S-Corporation

• If you plan to sell your S-Corporation, the taxable gain in the business can be less than if you set up your business as a regular corporation.
• You can declare business losses on your income taxes with an S-Corporation, offsetting your tax liability.
• You can minimize FICA and self-employment taxes. Shareholders’ profits are not taxed in this manner.
• You can raise capital more easily than as a sole proprietor or partnership.
• You have the limited liability protection without paying taxes as a corporation.

Disadvantages of an S-Corporation

• S-Corporations cannot have more than one hundred shareholders.
• The company shareholders cannot deduct the cost of fringe benefits provided to employees who own more than 2% of the corporation.
• A shareowner cannot deduct losses more than the amount invested in the company.
• Each S-Corporation shareholder has to be a U.S. permanent resident.
• Profits and losses for an S-Corporation are proportional to each member’s investment into the business.
• You must receive compensation before earnings are distributed to shareholders (i.e., you must pay the employment taxes). This is important when the shareholder is also an employee.

An S-Corporation’s earnings will pass through to your income taxes (no double taxation). However, you will have to maintain all the business records and comply with state regulations. Owners of an S-Corporation pay FICA on shareholders’ salaries, but do not pay for distribution of profits and earnings. The S-Corporation shareholder does not pay self-employment taxes on profits or earnings.

Things to remember: